The only sector that profits from takeovers
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MoneyWeek Editor
John Stepek Sep 08, 2009
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Happy days are here again as far as the City's concerned.
The mooted Cadbury / Kraft deal is grabbing all the headlines this morning. Excitement over the deal helped to drive the FTSE 100 back up over 4,900. The US market was shut for a holiday, which also prevented any nasty surprises from that side of the Atlantic from spoiling the party.
Rumours of other mergers deals are rife. It's like 2007 all over again.
Will it end the same way?
Merger and acquisition (M&A) deals get markets very excited. They shouldn't really. Mergers tend to destroy shareholder value. In the short term, the company being bid for will see its share price rise, but integrating acquisitions isn't easy, and the bigger the deal, the more likely the acquirer is to suffer from indigestion. M&A is a triumph of hope over experience, and short-term pound signs over long-term value destruction. And this deal looks no different.
Kraft needs Cadbury more than Cadbury needs Kraft
You've got Cadbury, a company with strong brands and solid growth in emerging markets. Kraft on the other hand, is rather more stolid. As Damian Reece puts it in The Telegraph, Kraft needs Cadbury more than Cadbury needs Kraft.
But what's most likely to happen is that the more dynamic business ends up being subsumed in the less dynamic one, as both management teams take their eyes off the ball amid all the politicking and in-fighting and culture-clashing that digesting an acquisition entails.
More to the point, as Rob Cox points out on Breakingviews.com, although everyone is criticising Kraft's offer as being low-ball, it won't be that easy for the company to raise its bid. Its balance sheet already looks stretched. Cadbury might be worth more, but Kraft is offering as much as it can comfortably afford. We should have learned all about the dangers of jacking up debt in the name of empire building. But it's as if the Royal Bank of Scotland / ABN Amro deal never happened.
What's also rather amusing about all this, of course, is the fact that suddenly everyone reckons that Cadbury is worth far more than the 745p a share that Kraft is offering. 800p seems to be the minimum anyone thinks Kraft should be paying, with others suggesting prices north of £10 a share, and even £12. Yet before the deal was announced, Cadbury shares were trading at well below 600p a piece. So much for efficient markets - or maybe the bulls are just getting overexcited.
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You could buy Cadbury's shares in the hope that another bidder will come along. But do be aware that if you do so, you're taking a punt, not investing. If the deal fell off the table, the share price would fall, though perhaps not back to where it was before, now that everyone has been reminded about this "jewel" of British industry.
The only sector that will profit from an M&A boom
The one sector which will genuinely profit from an M&A boom is the investment banking sector. The fees (I suppose you could call them transaction taxes, if you were feeling cynical) that the financial giants collect for organising and encouraging this deal for example, will run into the hundreds of millions of pounds, reports The Telegraph. That's OK, everyone argues, because the City is a hub of rampant wealth creation. But if the end result is a company which is both less efficient and less productive than the two companies you started out with, then this is wealth destruction, not wealth creation. You might as well applaud divorce lawyers for their importance in propping up the British economy.
Matthew Lynn has more to say on the downsides of M&A in this week's edition of MoneyWeek, out on Friday (if you're not already a subscriber, claim your first three issues free here).
Are we close to a turning point for the market?
Meanwhile, another driver behind yesterday's gains, reports The Telegraph, was the fact that "some of the more bearish equity strategists had capitulated." Morgan Stanley's Teun Draaisma, who was pretty good at calling turning points in the midst of the crisis, has said that he expects the rally to continue. He's worried about the economy in the medium terms, but says "we intend to buy on weakness."
To be fair to Draaisma, this is hardly capitulation. He noted back in the middle of August that the rally could go much further, and he's always been pretty good at hedging his bets – an uber-bear he's not. However, this notion that "capitulation" by bearish investors is good for the rally is wrong-headed in any case.
A market rises because there are more buyers than sellers; it falls because there are more sellers than buyers. That's it. As long as there's a supply of bears to be turned into bulls, the market can keep rising. But once all the bears have 'capitulated', there's no one left.
That's why this notion that markets will be shielded from big falls by "all the money sitting on the sidelines" isn't to be relied upon either. Because what actually happens is that as the market rises ever further, all that "money on the sidelines" gets fed up waiting, and scared of missing more gains. So it starts to buy at any level. The market has one bad day and drops off, say 50 points, and fund managers frightened of their next performance review, use it as an excuse to "buy on the dips".
So by the time the big correction finally comes, any money that's actually left on the sidelines belongs to the die-hard bears who have no intention of getting in unless they see a really big fall.
This is one reason why the September / October slump that everyone's expecting might come a little later than expected this year. Those who aren't already in the market have been crossing their fingers for an autumn slump, in the hope of getting in then. As the market stubbornly refuses to collapse, more and more of the hold-outs will throw in the towel and buy.
Then, when everyone's least expecting it, the big correction will come.
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